Guarantees and their application to banking risk in Cuba

Goals:

Characterize the different Guarantees existing in Cuba and their application in banking Risk Determine the existing problems in the use of guarantees and their operation within the Banco Popular de Ahorro.

Foundation

Guarantees in our country are an important working instrument for the bank; Since the risk factor is something inherent in bank financing, in certain circumstances an active use of guarantees is essential as part of the adequate structuring of financing. The risk of these operations makes it advisable for banks to ensure their collection through alternative payment sources.

The most important element in the evaluation of a Banking Risk at the time of granting a financing will be the possibility of its normal recovery, basically determined by the debtor's payment capacity; therefore, the guarantee should be considered as a subsidiary element, as a second instance to recover the loan, not diminishing the importance that this merits.

Banking Risk is linked to the uncertainty that generally surrounds any economic event, in the sense of contingencies that may cause losses.

It can almost be said that taking risks is the business of bank management. A bank managed on the basis of avoiding all or as many risks as possible will be a stagnant institution, and will serve the credit needs of its customers in a deficit way. However, an institution that takes excessive risks, or assumes them without yet recognizing their existence or magnitude, will surely encounter difficulties.

The concept of risk is highly complex in the financial business given the multiplicity of forms it presents and the interrelationships between them.

That is why, in these moments where financing to Companies has grown and where the Bank is in charge of assuming these situations, it is where the use of Guarantees as a way of recovering credits should be taken with greater importance and knowledge. granted.

Introduction

Financial institutions, in general, cannot remain in the market if they do not grant credit, but in doing so they assume risks such as suffering losses due to the financial weakness of a client; not being able to collect, due to non-compliance with payments, and even facing the consequences of future adverse movements in the prices of products in financial markets.

Bank Guarantees, the object of this paper, are very often the poor relatives of commercial negotiation and, particularly, of its financial aspects. In the contracts signed between exporters and importers, producers or traders and the Bank, they come after technical and price considerations.

Obviously, the absence of guarantees or their weakness can reduce or even completely eliminate the expected benefit of a business, since due to insufficient protection against arbitrary appeals that the beneficiary may make of the guarantee, because they do not can be executed.

The main objective of this paper is to offer a panoramic view of the main aspects related to bank guarantees, their characterization and their use in reducing the risk to which the bank is exposed at the time of its commercial relations.

Obviously, this work constitutes a general point of reference based on theory, in order to offer a greater knowledge of the existing guarantees and thus be able to give an adequate response to the continuous and new situations that are being created in our system. financial, more complex and dynamic.

CHAPTER I. Guarantees. General

1.1 The Guarantees. General features

The concept of guarantee extends its roots to all branches of law; However, its extensive manifestation does not in any way prevent it from preserving in each of its expressions the specificity and precision necessary to prevent its conversion into a vague concept.

From constitutional guarantees to procedural guarantees or in the substantivity of real or personal guarantees, there is a fundamental principle at all times: that of protection. In this way, it is possible to confirm that the purpose pursued by the guarantee is none other than to provide security, protection or defense that, as a duplication of that general concept, vivifies legal institutions.

Starting from a broad conception of guarantee, it has been said that any means to ensure compliance with an obligation or the enjoyment of a right can be considered as such, any measure established to ensure the effectiveness of a credit, in this sense they can be understood as a function of guarantee from the assets of the debtor in breach of the obligation, to the inscription in the Property Registry, through the witness or document evidence, or the causes of priority, the real guarantees, the assignment of credits, the right of retention, etc.

The warranty-liability connection is understood to be derived from the rule of article 111 of the Cuban Civil Code. It means that in the event of non-compliance with the same, the creditor may request compulsory execution of the assets that actually form part of the debtor's assets and obtain compliance against them. This is the generic responsibility of the debtor that serves as a guarantee for all obligations, it is the normal system of responsibility established by the legal system.

The legal meaning of the term Guarantee is that a third person, who is not a party to the contract, assumes the obligation in the event that one of the contracting parties breaches its obligation. Legally the word Guarantee is used and in trade, sometimes it simply denotes commitment.

According to the definition given in the Encarta Encyclopedia, “Guarantee, in civil and commercial law, is a legal mechanism to protect or ensure the commitment that a certain obligation will be fulfilled in a timely manner. Above any other guarantee, the Law knows the so-called universal patrimonial guarantee: every creditor, regardless of the origin of the debt, knows that the person obligated to pay is responsible for the fulfillment of his obligation with all his present assets and even with the that you may have if your fortune improves (future assets of the debtor).

However, as it may happen that the debtor is insolvent and the guarantee vanishes, there are other additional formulas to reinforce compliance with the obligation. The most important are listed here:

a) the surety or guarantee, which involves an agreement by which a third party assumes the condition of obligated with a subsidiary nature of the payment, to face the event that the main debtor does not comply;

b) the pledge, which means the initial delivery of possession of a personal property to the creditor or to another person, so that if the debtor does not pay, the thing pledged may be sold at public auction, and with the amount of the sale, collect the creditor;

c) the mortgage, which makes a certain real estate subject to compliance with the obligation;

d) the lien, which allows the person who has carried out a work or repair on someone else's personal property (for example, the mechanic who repaired the car), to delay the delivery of the property until the price of the property is paid. such work or repair;

e) the deposit, or signal given by the buyer as part of the price in guarantee of the future acquisition of the thing;

f) the penal clause, which implies the establishment of a financial penalty in the event of non-compliance (for example, it is agreed that for each day of delay in the delivery of a building, the builder will cease to receive a certain amount of money).

When it comes to a salary debt, the guarantees that workers have for the collection of their wages usually have special treatment in the law and also preferential with respect to other obligations that the employer must face.

From another point of view, if in the criminal process there is the possibility that the judge, in certain circumstances, grant bail, it is above all so that said bail guarantees that the defendant will not evade the action of justice. "

The Larousse Encyclopedia, raises as a definition of Guarantee, the responsibility assumed by the contractor; surety, pledge. Thing that ensures and protects against some risk or necessity.

Seen in a general way, the term Guarantee has a vague content that always needs to be clarified, since when the Bank requires its clients to present guarantees, it is generally understood quite quickly what they want, without knowing what exactly, if it is a surety, a pledge, a mortgage, an assignment, etc.

The Bank Guarantee is defined as the irrevocable obligation of a bank to pay a sum of money, in the case of non-fulfillment of a contract by a third party. This guarantee constitutes an accessory contract linked to a main one, which tends to ensure compliance with the obligations derived from the latter.

In banking practice, the guarantee constitutes a commitment by the guarantor to pay a specified sum of money and in a specific currency to the beneficiary, at the first request of the beneficiary against the claim that the principal has not fulfilled his commitments to the beneficiary.

1.2 Qualification of the Guarantee Function.

Its general characteristics.

The approach to the concept of guarantee, without a doubt, must start, according to what has been said above, from an approach and study of the relationship of responsibility within the main guaranteed obligation, because the contracting of a guarantee is always aimed at ensure the liability of the debtor to the creditor.

The credit guarantee, which may have a legal origin (for example, order of priority or privileges) or voluntary (pledge, mortgage, bond, etc.), seeks by any means to achieve the creation of rights added to the obligation that they will try to ensure their compliance.

The guarantees themselves (guarantees of the obligation), those that are located in the civil law treaties as such, whether they have a real or personal nature, generally have a conventional origin, a reason that points to the contract as the sole and essential source of the same, having as more general characteristics those of subsidiarity, accessory, and additionality.

The accessory nature of the guarantees has its normative manifestation, an example of this can be found in the text of articles 257.2 (the assignment of a credit includes all of its guarantee rights), 264 (the guarantee or pledge offered as guarantee by a third is without effect if the guarantor or pledge debtor does not ratify it in favor of the new debtor), 285.1 (the extinction of the main obligation implies that of the guarantee that guarantees it), all of the current Civil Code. However, accessority is not an unalterable characteristic in the guarantees, since they could be voluntarily constructed as independent or autonomous.

1.3 Types of Guarantees Regulated in Cuban Legislation

At this point in the presentation of ideas on the subject of guarantees, we can make a distinction between them both from the doctrinal point of view, as well as the regulation that the Cuban Civil Code offers on it.

The table of credit guarantees would be made up as follows:

Personal guarantees, the most typical, the surety (art. 280 to 285). The Cuban Civil Code also recognizes the authorization of discounts (art. 287), and the pecuniary penalty (art. 268 and 269). Real guarantees, real security rights: pledge (art. 270 to 277), mortgage (art. 288), withholding (art. 278 and 279) and advance (art. 286).

In Book Three "Right to Obligations and Contracts", Title I "General Obligations", Chapter III "Guarantee of compliance with obligations", the different guarantees regulated in Cuban Legislation - Law No. 59 (Civil Code) appear.

1. The pecuniary penalty: By virtue of the pecuniary penalty, the debtor contracts the additional obligation to pay the creditor a sum of money in the event that he fails to comply with his provision. (Second Section, articles 268 and 269).

2. The pledge: the right to the pledge empowers the creditor to satisfy his credit preferably to any other creditor, charged to the value of a personal property received from the debtor.

However, a pledge can be constituted without dispossession of the asset, but only in favor of state credit institutions. (Third Section, articles 270 to 277).

3. Retention: The retention right confers on the creditor the power to keep in his possession an asset belonging to the debtor, until the latter pays the credit arising from work performed on the same asset or the benefit derived from other contracts is satisfied. (Fourth Section Articles 278 and 279).

4. The bond: By virtue of this, a person assumes, in front of the creditor, the obligation to fulfill instead of the debtor in case of not doing so. (Section Fifth articles. 280 to 285).

5. The advance: The debtor can deliver an amount of money to guarantee the obligation he has contracted. (Section Six Article 286).

6. Authorization of discounts: in contracts entered into with banks or other state entities, the debtor can guarantee the fulfillment of his obligations by authorizing discounts on his salary or other periodic income. (Seventh Section 287).

7. The naval or air mortgage: It is governed by special provisions. (Section Eight Article 288).

CHAPTER II. Bank guarantees and bank risk.

2.1 The Bank Guarantees.

Bank guarantees are instruments that accompany contracts such as Investment Loans, Lines of Credit, Leasing Contracts, Factoring Contracts, Commercial Discounts, etc., as well as International Contracts such as Contracts for the Supply of goods of all kinds, for the Provision of Services, for carrying out works and loan contracts.

In international banking practice, guarantee development has focused on personal guarantees.

In contrast to the operation of real guarantees, personal guarantees increase the security of the creditor using other methods. Personal guarantees are directed against the assets of the debtor himself or of a third party, in which case the possibility of aggression by the creditor is increased if the breach occurs.

The most important difference that personal guarantees have with respect to real ones, lies in their guaranteeing technique, which does not encumber specific assets, but tends to increase the number of responsible patrimonies.

In International Trade, taking into account the purpose or objective of the Guarantees, three main types of guarantees can be observed.

1. The Bid guarantee

It is one that seeks to ensure the commitment of the party that attends a tender, to sign the contract in accordance with the offer, if it is accepted.

The guarantor bank undertakes to pay, on the first request to the beneficiary, all or part of the amount of the guarantee, in the event that the Bidder refuses or is not in a position to sign the contract or to issue guarantees provided for in the tender specifications..

2. Performance Guarantee

Its objective is to prevent the eventual breach by the principal, of the obligations contracted in the contract, up to the date or dates set for the fulfillment of the same.

3. Guarantee of Refund or Refund of Payment

Its purpose or objective is to assure the beneficiary of the same the return of the advance payments by him, in the event that the principal does not comply or does not comply with the terms of the Contract.

Among the Guarantees used in banking and commercial practice in our country are:

1. Letters of Sponsorship or Letters of Guarantee

They are instruments or letters issued by a parent company of a group of companies to a bank, in which it assumes the commitments of its subsidiaries, which have carried out a banking operation with the credit institution.

2. Guarantees on First Demand

In this Guarantee Contract between the Bank and the beneficiary of the same, the latter is only obliged to comply with what has been agreed in regard to the claim and transfers the burden of proof to the person of the originator (of the guarantee) who will be the one obliged to act judicially or extrajudicially and demonstrate the breach or defective performance.

3. Deposit

The surety is defined when a person assumes in front of the creditor, the obligation to fulfill instead of the debtor in case of not doing it. The guarantor's obligation is subsidiary insofar as he undertakes to fulfill the obligation in the event that the debtor has not done so (exclusion principle). - Article 280 of the Civil Code.

4. Subrogation of credits

When after studying the balance of a client, it reflects an unsatisfactory current position, because there is a loan to be paid in favor of a third party, this creditor being preferential with respect to the bank, it may be considered necessary to obtain a credit subrogation in favor of the bank, of the credit that said third party has against the client, this creditor committing himself not to collect the said credit, until the bank does not make his own.

5. Pledge of bank deposit balances

The purpose of this guarantee is to affect a certain bank deposit to the fulfillment of an obligation, before the depository entity itself, or against a different one, with the fundamental objective of achieving the enforceability of such guarantee against third creditors, in order to obtain the preferential collection of the credit through the execution of the right thus constituted, given the power that the owner of the deposit grants to the creditor so that he can confuse in his patrimony, with the secured pledge, the entire guarantee in case of insolvency of the debtor.

6. Insurance as a guarantee

An insurance contract can be defined as the one by which the insurer is obliged by collecting a premium, and in the event that the event occurs whose risk is covered, to compensate, within the agreed limits, the damage produced to the insured.

There are two large groups: people and property or against property damage and within the latter we have credit insurance, loss of earnings insurance, surety or surety insurance and others.

7. Parts Store

It is that guarantee in which the tax is established on a set of goods and rights that, for this purpose, are constituted in a production unit, which is generally agricultural.

In the repair, the owner, possessor, lessee or usufructuary of a production unit taxes the fruits or products of the same, referring to the years or harvest that are specified, with the purpose of responding to the payment of the amounts they receive for the concept of loan, your interests and other legal responsibilities.

8. Trust

In the guarantee trust, the settlor, who is in turn the debtor, allocates certain movable or immovable property to guarantee a specific purpose, and entrusts the realization of this purpose to a fiduciary institution, which acts as depositary, or administrator of those goods. The trustee delivers the trust to the creditor or trustee, as the person who receives the assets as security for the debt.

9. Transfer of sales contracts

This modality consists of the transfer of the contract, or of the rights over it. It is a typical form of secured financing. In the same it is frequent the use of an escrow account in which the amounts of the sales of the product or contract are deposited and from which the settlements are made.

10. Payment commitment

The payment commitment (Payment undertaken) is the guarantee issued by a large firm, with recognized prestige, by means of which it undertakes to pay an amount of money, which will cover an operation, usually commercial. This type of guarantee is sometimes issued by a main lender in favor of a borrower, so that the latter can obtain a bridge loan, due to difficulties in locating the necessary funds on a date. This form is mutually advantageous for both parties, since the main lender fulfills a commitment without placing funds, which he does not have, and the borrower receives them through a third party in the desired time.

2.2 The Banking Risk

The concept of risk is highly complex in the financial business given the multiplicity of forms it presents and the interrelationships between them.

To sink risk is a business of bank management. A bank managed on the basis of avoiding all or as many risks as possible will be a stagnant institution, and will serve the credit needs of its customers in a deficit way. However, an institution that takes excessive risks, or assumes them without yet recognizing their existence or magnitude, will surely encounter difficulties. Risk is linked to the uncertainty that generally surrounds any economic event, in the sense of contingencies that can cause losses.

As a definition of Banking Risk we can say that it is the probability that the prices of the assets owned will move adversely in the face of changes in the macroeconomic variables that determine them, in general, it is the risk that the Bank assumes when financing third parties.

2.3 Main Types of Risks.

The business of bank administration is to take risks, so it is necessary to evaluate the institution's recognition of the risks it assumes and the measures it must take to control and monitor them.

Among the main types of risks that all banking institutions generally assume are:

Legal Risk: Involves the risk of a loss caused by the impossibility of making a contract effective, this includes the risk arising from operations that are legally flawed from the beginning, from adverse legal situations for the institution such as the uncertainty of the legality in cases of bankruptcy or insolvency, the lack of complete and adequate documentation of the operations, and the lack of authority of the counterparty to carry out the operation.Credit Risk: It is the risk that a counterparty does not pay an obligation to its creditor on the due date or any later date. It is also considered in this class, the risk assumed by a financial intermediary, when it pays obligations of a client without there being sufficient funds in its bank checking account.Credit risk arises when one of the participants becomes insolvent. Liquidity Risk: It arises when a counterparty does not pay on the due date, although it is able to ensure payment at a later date.

2.4. Bank guarantees and their application to banking risk

Guarantees constitute an important working instrument of the Banking Financial System; Since the risk factor is something inherent in bank financing, in certain circumstances an active use of guarantees is essential as part of the adequate structuring of financing. The risk of these operations makes it advisable for banks to ensure their collection through alternative payment sources.

To this end, the Bank must know the financial health of the client and, in accordance with it, determine the characteristics of the guarantees that could be requested to support an operation, and must take note of their limitations, the procedures necessary for their constitution and their effectiveness in the event of insolvency of the debtor.

Although guarantees seem to solve all the Bank's problems in its work of granting financing, it should be noted that banking practice teaches that this is not the case. A credit risk policy for healthy financing recommends not basing a loan on the sole argument of the guarantees constituted, this is because the ability to discern between good and bad financing, due to its low or high risk characteristics is the fundamental competitive advantage of a bank, therefore basing the development of the banking business on rigid procedures to guarantee financing, prevents adequate competition for the bank in the market.

The most important element in the evaluation of financing will be the possibility of its normal recovery, basically determined by the debtor's ability to pay; therefore, the guarantee should be considered as a subsidiary element, as a second instance to recover the loan.

As a general rule, for operations both in national currency and in freely convertible currency, guarantees are required for the granting of financing, which must cover all of the debt or money loaned.

Among the most used guarantees in the Popular Savings Bank and taking into account the regulations established by the Central Bank of Cuba as Resolution No. 17 of 2005, the following are used in our province:

Bills of Exchange endorsed by the Bank where Bank Guarantee operates. Assignment of sales contract to customers. Insurance. Escrow or escrow account:

The requirements and elements to be taken into account for the issuance of each of them and the reality in current banking practice are detailed below.

1. Bills of Exchange endorsed by the Bank where they operate, used mainly in financing in CUC.

The Bill of Exchange is a formal and complete title of credit, which obliges to pay at maturity, in a specific place, a certain amount of money to the person first designated in the document, or to the order of this to another other also designated. The payment mandate contained in the letter is a pure payment mandate, not subject to any conditions, and the obligations incorporated into the title (in the case of several obligated parties, they are always joint and strict).

As a guarantee, it is an effective means of payment that makes it possible to pay several successive debts replaces the use of cash. It also fulfills an important credit function, firstly because the term for the payment established by the bill, offers the debtor a time to provide funds to carry it out, and in turn, the creditor can reduce this term that mediates between the issuance and the maturity of the the letter, discounting it at a bank or financial institution. They can also perform the function of guarantee if the bank, when granting a loan, writes a bill for the amount of the amount loaned and this is accepted by the debtor, thus having as a supplementary guarantee of the obligation arising from the loan, the most rigorous obligation of the letter.

When a Bill of Exchange is guaranteed, it is exclusively aimed at guaranteeing the payment of the bill. The normal thing is that the guarantor is a person outside the exchange circle, but nothing prevents her from being included in it, of course with the exception of thecoholtor. The guarantee may be aimed at guaranteeing the obligation of the acceptor himself, the drawer or any other previous endorser, it being understood, if not expressly indicated, that the acceptor is guaranteed.

The guarantor assumes the same obligations as the guarantor, so the policyholder may demand its compliance without having to previously prove the insolvency of the latter.

The Document issued by the Central Bank of Cuba related to the use of bills of exchange, promissory notes and checks in the national territory (Resolution 56/2000 and 64/2000) sets out the recommendations for the use of bills of exchange.

Currently, this is a truly effective guarantee in our province, because if the client (debtor) does not comply with its main obligation, the Bank as a financial entity or other non-bank financial entity that guarantees the operation assumes the payment.

2. Bank Guarantee

It consists of the commitment of a banking institution to pay, at the first demand of the creditor, the amount due and not paid by the debtor, for that reason it is very safe.

With this guarantee, other collateral is generally not required, since it is a bank that is committing to pay with its assets, which covers all risks.

This guarantee must also cover the amount and time of the financing contract, and be irrevocable and unconditional. A partial bank guarantee can be accepted, that is, it covers only one part of the financing, as long as there are other guarantees that back up the rest.

3. Assignment of Contracts

Some prerequisites:

Review the contract where the rights or credits to be assigned are regulated (it can be of sale, lease, services) once signed by the parties, and evaluate if the conditions and terms stipulated in it are correct and sufficient as to protect the compliance of the business. That the payment terms coincide as exactly as possible with the repayment terms of the credit, so that we can collect directly from the flows from those payments, or if it is not agreed so, unless we makes it possible to compensate us in a short time against the borrower's non-payment. That the term of the assigned Contract is greater than the term of the financing.

In the current reality, the debtor companies of the bank's clients, whose contracts assign as Guarantee, sometimes do not have sufficient solvency to honor the debt, so in this case, the guarantee offered and accepted by the bank is not totally effective..

4. Insurance

The issue of the Insurance Guarantee was discussed previously, having only to add that the insurance is used mainly for the agricultural sector, where the Bank must appear as the beneficiary of the insurance policy.

Currently, agricultural producers, Basic Units of Cooperative Production, Credit and Service Cooperatives, Agricultural Production Cooperatives (insured) and others of the agricultural sector, at the time that the claim or claims that were insured occur, do not urge the time established before the Insurance Company to claim payment thereof. In this regard, the Guarantee becomes untimely and loses all execution value.

Taking into account the above, it is essential to dedicate space to some aspects that the text of the guarantees must contain and that must be taken into account at the time of a better application of these.

Maximum limit of liability assumed by the guarantor: the obligation will be expressed in a fixed amount of money or the percentage of a certain price or value.Validity of the guarantee: It may well be valid from the date of its issuance, or be fixed in its text at the moment from which it will be considered valid.Execution deadline: All or almost all the guarantees are subject to a conventional expiration period to avoid the guarantor being unlimitedly subject to a claim. Escrow or Escrow Account: Es an account that is established by virtue of the execution of a financing agreement, and represents a guarantee for the lender.

In the current reality, the use of this account occurs in the financing of bank loans and Credit Lines by Tomas and it turns out to be very effective in recovering the financing granted.

Conclusions:

Carrying out this research has led us to conclude the following:

1) Guarantees have been defined in a general way as a legal mechanism to protect or ensure the commitment of a certain obligation where its main task is to protect and ensure a certain obligation that will be fulfilled or breached in a future time.

2) The types of guarantees recognized by Cuban legislation are regulated in the Civil Code and are classified as personal and real, both differing in that the personal ones increase the creditor's security by increasing the creditor's aggression if non-compliance occurs, as it is not taxable specific assets but tends to increase the number of liable assets by targeting the assets of the debtor himself or a third party.

3) In international banking practice, the development of guarantees has been condensed into personal guarantees.

4) The Banco Popular de Ahorro foresees in its Regulations the use of operational guarantees, however, the country's legislation is very poor in this matter, and does not offer many alternatives at the time of a recovery of financing, therefore, the guarantee is considered as a subsidiary element.

Bibliography

1. Ten Picazzo. "Fundamentals of Civil Patrimonial Law". Madrid, 1991.

2. Roca Trías, E. “Basic Features of the Spanish Regulation on

Guarantee Business. Treaty of Guarantees in

Commercial Contracts ”. Madrid, 1996.

Encyclopedias

1. Basic Civic Encyclopedia. Madrid, 1995.

2. Legal Encyclopedia SEIX. Barcelona, 1960.

3. Microsoft ENCARTA 2000 Encyclopedia. 1993-1999.

Legal Norms

1. Resolution No. 17/2005. "Rules on Minimum Requirements for the opening of Bank Accounts in National Currency by Legal Entities" Banco Central de Cuba, 2005.

Journals

2. Magazine of the Central Bank of Cuba. Year 3, No. 2, April - June 2000. Publication by the Center for Banking and Economic Information (CIBE).

3. Magazine of the Central Bank of Cuba. Year 4, No. 1, January - March 2001. Publication by the Center for Banking and Economic Information (CIBE).

4. Magazine of the Central Bank of Cuba. Year 5, No. 2, April 2002. Publication by the Center for Banking and Economic Information (CIBE).